The rise of the shadow economy: An Indian perspective

• Published date: 01 February 2019
• DOI: http://doi.org/10.1002/pa.1880
• Date: 01 February 2019
• Author: Priyanka Menon

PRACTITIONER PAPER

The rise of the shadow economy: An Indian perspective

Priyanka Menon

Institute for Financial Management and

Research (IFMR), Chennai, Tamil Nadu, India

Correspondence

Priyanka Menon, Institute for Financial

Management and Research (IFMR), No.24,

Kothari Road, Nungambakam, Chennai, TN,

India.

Email: priyanka.menon@ifmr.ac.in; priyanka.

hmenon@gmail.com

JEL Classification: H10; H26

This study was undertaken to understand the importance of the shadow economy,

which is often misunderstood and misquoted. We come to an understanding of why

this is an uproar regarding black money generation in India. This paper is an attempt

to bring forward past evidences and current situation to understand the system

through discussing various points of views in the literature. The paper concludes with

bringing out the difference in black wealth and black money and the impact of both

on the economy and answers the question—Is black money really bad for the econ-

omy? It is a hope that these results will be useful to policymakers and stakeholder

to make policies that cater to all.

1|INTRODUCTION

Corruption has always been one of the foremost concerns of the

civilians as well as the bureaucrats of any country, and the case of

India is no different. India is a growing country, which marks it as a

fertile ground for the undesirable activities. Therefore, these activities

attribute to a development of a large shadow economy for India. From

the eyes of a common man, the “shadow economy”is experiencing

quite a celebrity status in India, especially after the 2014 parliamen-

tary elections. It was one of the most sought after agenda used by

the winning government in India. The winning government promised

to bring out the lurking black money keeping up with their

election campaign, which particularly revolved around the agenda.

Having said so, “shadow economy”has gained lot of prominence in

the current scenario.

The growth in the “shadow economy”has been on a rise for a few

decades now. When observed more specifically, one finds that the

“shadow economy”has been on a rise from the 1970s, and this period

is marked with the rise in the government interventions in the market

activities around the economies of the world. It is observed that the

rise in taxes and other government regulations to finance the larger

public spending lead the countries around the world to this situation,

hence, which lead to the growth of the shadow economy. To quote

Tanzi (1999) “Thus a good case could be made that what came to be

called as the underground economy was a phenomenon to worry

about. Newspaper articles were ready to accept the notion that the

underground economy had increased significantly over the years, thus

casting doubts on the accuracy of the official economic statistics and

raising the prospect that large increases in tax revenue were possible,

if only the underground could be taxed”. Common sense points to the

fact that the shadow economy causes inefficiency in the functioning

of the labor market and the market of goods and services and also

introduces unfair competition among companies as well as disturbs

the relation between the fellow countries. It attracts workers from

the official economy, harming them by depriving them of their rights

and guarantees, and produces a vicious circle, since their exodus from

the formal economy reduces tax revenues and consequently the

state's ability to conduct public expenditure. Moreover, the shadow

economy favors corruption and the lack of confidence in institutions

and feeds resentment among citizens. However, in the opinion of

several others, the shadow economy does generate positive effects

for a country. Schneider and Enste (2000) state that at least two thirds

of the income obtained in the shadow economy is immediately spent

in the official economy, thus generating a positive net effect.

Though the existence of the shadow economy is felt all over the

world, we would focus on India. To get a clear understanding of this

aspect, one should always understand the structure of the Indian

economy. Indian economy is a very heterogeneously divided econ-

omy. There are differences in almost all the walks of life; there is a

huge disparity between the south and the north and the east and

the west, and the differences in cultures, customs, and language add

to it. There is also a vast demarcation in the labor market. India being

a large country with a projection of gross domestic product (GDP) to

grow at 6.7% in the financial year 2017–2018, yet it has a very large

informal sector and a very small formal sector. The workers from the

informal sector constitute 92% of the total workforce (Kannan and

Papola (2007)). Hence, the formal sector is represented only by a very

small part of the economy.

Over the years, we have seen that this search of unknown has got

a lot of attention, and various scholars have tried measuring it using

Received: 23 August 2018 Accepted: 27 September 2018

DOI: 10.1002/pa.1880

J Public Affairs. 2019;19:e1880.

https://doi.org/10.1002/pa.1880

© 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/pa 1of7